Understanding South Dakota Trust Distribution Standards is essential for beneficiaries and trustees alike. Under South Dakota law, there are distribution standards that relate to 3 different types of beneficial interests in South Dakota trusts: discretionary interests, mandatory interests, and support interests. The distinction between these interests is important primarily for asset protection purposes, and not US Federal estate tax or income tax.
Discretionary Interests in South Dakota Trusts
The trust instrument may grant trustees pure and unfettered discretion over whether to make or withhold distributions. Such discretionary interests are neither property interests nor enforceable rights, and beneficiaries are considered to have mere expectations. Beneficiaries of discretionary interests have no enforceable right to receive distributions. Creditors may not compel the trustee to make distributions, and the trustee may make distributions to beneficiaries without incurring any liability to creditors. A reasonableness standard does not apply and a court may review a trustee’s exercise of discretion only if the trustee acts dishonestly, with an improper motive, or fails to act.
Mandatory and Support Interests in South Dakota Trusts
The trust instrument may also provide for mandatory interests, with respect to which the trustee has no discretion in determining whether a distribution should be made or the amount of the distribution. Finally, the trust instrument may provide for support interests, which require distributions to be paid but are subject to a reasonableness or other standard capable of judicial interpretation, such as the Health, Education, Maintenance and Support (HEMS) standard. Beneficiaries of mandatory or support interests have enforceable rights against the trustee to receive distributions, which are subject to judicial review under the reasonableness standard. However, where the trust instrument contains a spendthrift provision, creditors may not compel distributions of mandatory or support interests.
Asset Protection Benefits of South Dakota Trust Distribution Standards
The applicable distribution standard plays a critical role in asset protection. Trusts with fully discretionary interests offer the strongest asset protection, and are the most commonly used for Dynasty trusts. By contrast, trusts with support interests offer weaker asset protection because beneficiaries may compel distributions, and creditors can reach such distributions once they are made. Trusts in which beneficiaries hold mandatory interests generally provide the weakest asset protection.
US Federal Estate Tax and Income Tax Implications
In general, the distribution standard is far less relevant for US estate tax purposes than the degree of control exercised by the beneficiary over the trust, which may result in US estate tax inclusion. However, where the beneficiary also serves as trustee, or holds a power to direct distributions, limiting distributions to the HEMS standard may keep the trust assets out of the beneficiary’s taxable estate. Similarly, for US income tax purposes, beneficiaries with distribution powers limited to the HEMS standard would not generally be treated as the “owners” of the trust and may avoid income tax attribution.
Long Term Planning Benefits
Settlors who wish trust funds to last through multiple generations typically establish fully discretionary trusts, and to a lesser extent discretionary trusts subject to the HEMS standard. Accordingly, funds not distributed during one generation remain in trust and can continue to provide benefits to future generations.
